I worked in Japan for more than 12 years in the eighties and nineties, in Osaka, Nagoya and Tokyo with the U. S. State Department, Citibank and Merrill Lynch. After many more years in China in banking (Deutsche Bank and Ping An Bank) and consulting, I am back in Tokyo conducting the business of Yangtze Century Ltd. (Hong Kong/Shanghai) and producing this blog. E-mail me at smharnerco@yahoo.com.

At 24 times central government tax revenues, cumulative Japanese government debt has reached a level which ensures financial collapse.

With the Abe/Aso government setting a 2% inflation target, the collapse will occur sooner—probably within the next 18 to 24 months.

The revelation will be that interest on the debt—currently 25% of national tax revenue—will double under higher interest rates.

The result will be massive JGB selling, a collapsing yen, and systematic financial crisis resulting from a collapse in yen asset prices.

Kyle is bearish on all yen denominated assets and liked buying Japanese stocks to “picking up a dime in front of a bulldozer.”

Today, with thanks to Richard Solomon in Tokyo, publisher of the frequently penetrating Beacon Reports on things Japanese, I am able to present (or I should say summarize–as the original longish interview is in Beacon Reports’ February 11 issue–here) the highly persuasive rebuttal to Bass from Jesper Koll, managing director and head of Japanese equity research at JP Morgan Securities Japan.

Koll challenges Bass’s “dump yen assets” call on analytical grounds. Bass has not fully thought through some of his points, or has ignored contrary indications. While Abenomics–with its 2% inflation target and further Keynesian deficit spending stimulus–could increase pressure for higher interest rates, there will be no crisis, and there may not be higher rates. JGBs remain an attractive asset. Koll suggests:

Rising interest rates would of course raise debt service costs for all borrowers, and especially the hugely indebted government. But they would enable lenders–including household depositors–to charge higher rates on new debt and raise returns on non-fixed rate debt. Since net stock of private savings is larger than the net stock of public sector liabilities, Koll reckons that the overall effect on the economy would be positive.

Rising interest rates would not spell large losses for Japanese financial institutions because these institutions’ bond–and especially JGB–portfolios are largely held to maturity, avoiding the requirement to be marked to market. The institutions would have no incentive to sell, and ample incentive to hold the JGBs [the weighted average duration of which they have in any event been shortening to well under five years--Harner].

As to who is or would buy JGBs, the answer for the present and foreseeable near term future is: the Bank of Japan. BOJ is already committed to buying the entire debt out to a maturity of three years and a new governing board to be installed in April may extend the range to three to five years. Interest rates will rise only as much as BOJ will allow. This is why foreigners and domestic institutions are still buying the bonds.

Whether or not significant inflation develops in Japan depends on productivity. Significant increases in productivity could fully mitigate inflationary pressures.

There is plenty of room in Japan’s economy for raising productivity. Agriculture, in particular, has absymal productivity that could easily be raised through deregulation. Land policy that affects housing is another. Health care is another. Indeed, deregulation is needed throughout the economy. “The Abe administration must implement real deregulation, so that private investors put their savings and capital to work, by building new factories, new hospitals, and so forth.” [This is a point I emphasized in my post a week ago on Abe’s “Three Arrows” program.--Harner]

Will Abenomics succeed? Beacon Reports asks Koll. “At the end of the day, Abenomics is about creating an asset bubble,” he answers. More coherently Koll opines that Japan needs a dollar/yen exchange rate of between 85-95 and Abe must be able to push through structural reforms in agriculture and health care, successfully overcoming vested interest lobbies.

As a partial counterpoint to Martin Feldstein’s alarms over Abenomics, and broadly supporting Koll, the always brilliant Masaaki Kanno, a former BOJ official and now JP Morgan chief economist, writing in the February 3 Financial Times, asserts: “The key to understanding the success of Abenomics is the asymmetric response between the currency and the bond markets, which can be attributed to divergent inflation expectations.” Currency market participants, in which foreigners drive prices, have driven down the yen on inflation worries, while inflation expectations in domestic institution dominated JGB markets have remain subdued.

Kanno’s is not an endorsement of Abenomics. Rather, he voices deep concerns: “Abenomics is a great challenge to conventional economic wisdom regarding the soundness of fiscal policy and the independence of central banks.” The danger is that policies that “ignore fiscal soundness and central bank independence” create vested interests that are hard to overcome when a return to normalcy is needed In particular, warns Kanno, compromising central bank independence may be effective when trying to get out of deflation, but robust independence will be needed when the time comes to tighten policy.

There is so much warranting study in Japan, and lessons to be learned, as it responds to challenges–fiscal, monetary, economic, demographic, even social and geopolitical–ahead of much of the world. We can fervently hope that the lessons will be more of success than of failure.

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I fail to see why the Japanese government interest rate payments would rise with rising interest rate. I would imagine that their debt is in long term fixed coupon bonds and that would not change over night with rates. If anything, the value of Japanse govenrment debt would go down with rising interest rates due to the long duration.

So this is a duck with three legs, one printing money, two borrowing and spending on construction projects, and three, structural changes. Well the first two have already been launched repeatedly over the last two lost decades with the result of sinking back except with heavier debt. Economists are hedging their pronouncements on condition that structural reforms are enacted. Leaving the first two aside, the structural changes are the most important leg, the most long-term possible solution to lifting Japan out of stagnation. However, the structural changes required of Japan are such tar babies to the politicos that Noda famously became mum soon after taking office. Noda managed a small sale tax increase which has since been not mentioned by Abe anymore. The farm lobby enjoys such special powers I wonder how Abe can muster enough political capital to literally wipe them out. Just like bacteria, when a group sees policy that requires wiping out their whole foundation of power, it is survival fight time. Other special interests will need to be pushed aside as well; the distribution system, the construction cabal, the civil service, and the most nebulous of all, the Yakuza. Unless we become intimately woven into their networks, we cannot fathom how their spider’s web has ingrained into the core body of their society. Structural changes on massive scales threaten the established order, and their self interests. Structural changes on such scale mean war to the targets of these changes. Just remember when T Boon Pickens tried to take over a Japanese corporation. He was roundly given the bum’s rush and never went back. In 2012, Michael Woodford the newly made CEO of Olympus was again given another bum’s rush when he wanted to delve into the corrupt practices hiding losses of over a billion dollars. And in each case nothing happened to the established Old Boys’ Network. Abe being the scion of two high level political families dating from the militarist past is definitely not immune from the Ole Boys’ Club. One can imagine the numerous horse-trades necessary to give a second chance to this schlemiel of a princeling. They are all wishing him to succeed but NIMBY is already at work. That is the outlook of the most important third leg.. If it become lame, the other two legs are already wobbly. America wants a shopping list of 4 things: [1] American beef imports, partially acceded to [2] Japanese divorce courts to play fair with American spouses, not likely [3] US bases to remain where US wants, OK, to the grumblings of local citizens [4] TPP, well that takes up the third leg of structural changes again and I see a vicious circle. Abe’s pronouncements seem to indicate he wants his cake and eat it too. Not so fast. The pressures during his first administration was nothing compared with what is coming.

But who and could should buy them? The BOJ. So as to create an asset bubble. It seems that Japan is still trying to recover from its previous asset bubble and not doing a very good job of it. This plan is like giving a drunk more liquor expecting it to sober him up. Doesn’t anyone believe in fiscal stewardship anymore?

Otherwise, Koll hardly refutes Bass as the ultimate outcome of another asset bubble collapse would make Bass’ seem scenario mild in comparison. He is basing this economic scheme purely on hope with little basis to have any.

Kanno is simply mixing common sense concern with a desire to protect the BOJ. Ultimately, both men want to protect the status quo which has caused all of this mess.

Bass will be proven right most likely. Any positive outcome from Abenomics will come from a miracle on the level of the Divine Winds of 1274 and 1281.

I think Koll was overdramatizing–as is his wont–when he said Abenomics aims to create an asset bubble. His emphasis on the imperative of deregulation was certainly spot on. It is the one of the “three arrows” that is the real test of Abe/Aso’s leadership and will be the measure of his success. Kanno implied that we currently have a bubble in JGBs and it will get worse under Abenomics. I fervently hope that Bass is proven wrong, but, as you suggest, it may require another Kamikaze.

Agree with the deregulation but that’s going to be tough for Abe to accomplish as many of those regulations are there to protect the same corporations (keibatsu) that benefit from the weak yen. Perhaps Abe has made a deal with them to deregulate but as long as the government continues to subsidize those companies and drive up debt, the rest of the economy, especially under a high tax/weak Yen regime, will hardly benefit enough to kick start the economy.

On the other hand, deregulation could be just another term for joining the TPP (supported by the keibatsu) which will present the Japanese people with a whole lot of issues they could never have imagined.

Time will tell but it all smells like desperation and an attempt to maintain the status quo regardless of the long-term effects on the nation.

[1] Currency War? For every dramatic Japanese action there will be reactions. This weekend the G20 will be meeting. While euphemistically the old G7 countries are meowing that there is no currency war happening; that is precisely what is on everyone’s backroom verbiage. Fair or not, the EU and US have only so much room to give to Japan before their hands are twisted out of shape, and it becomes every economy for itself.. The BRICS are keeping watch although a weaker Yen means they can pay less for Japanese goods. The printing of money has already affected the Asian stock markets. With cheap Japanese money, ‘some people” are already shifting into buying stock, and that blunts the intent of printing money. China for example buys less and less from Japan than Japan buys from China and while Japanese giants are suffering in the China market, China does not have to counter Japan’s moves. Furthermore, Japan is now fifth in terms of trade impact for China. So Japanese QE will not achieve the dramatic effect that is needed; rather the strength of QE will be sapped before it even gets out of the door. The financial markets of the world are even more interconnected than just 20 years ago and what Japan is putting out in quantity is small compared with the massive kicks of the US. [2] Informational Dissonance. When trying to turnaround a ship of state, one expects the usually analogous parts, motive force, direction course setting, effectiveness of the crew, the tolerances of the ship structure, fuel, and external forces of wind, tide, icebergs. On sheer accounting alone, Japanese corporations have already demonstrated a lot of creative reporting. The most nebulous part is the force of the underworld in Japan. In otherwords, without proper information, I would not be confident of steering this ship in any sort of turnaround at all. All I can do is use trial and error to gauge how much is needed of what policy application to get what result. That seems to me one of the manifestations of the last two lost decades; that we from the outside see only a façade being presented from which even the nominative leaders do not know for sure what their actions will truly impact. Some Japanese executives have said that about 30-35% of their large corporate budgets are in the “entertainment-public relations etc.” That may mean when I ask the engine room for a speed of 30 knots, I may get 20 knots, I may not. An even more dangerous aspect is how much their banks having been affected by the underworld syndicates’ loan-sharking. No one seems to have a good handle on the size of these two areas, and they impact significantly on the whole ship of state’s speed, discretion, direction, and ultimately well-being. If any world famous economists were to say they don’t factor in these “things”, that means he is predicting a safe journey not counting icebergs and tides. Remember Milton Friedman was on the board of Lehman Brothers; and Greenspan was “highly regarded” before the ninja loans surfaced. I should get back on point. No, there will not be a massive implosion. The many legs of the Japanese power centers are all nepotistically from Tokyo University. These Boys have been in cahoots for two decades trying to cover each other’s bottoms and quite seamlessly also. So you can expect a series of “adjustments” going from whimper to whimper.

On number two. Just because they hold to Maturity does not mean they will not cause a panic. Its called mark to market. Japan large banks have 1000% their capital in JGBs whereas in USA the large banks have on average 100% of their capital in US Treasuries. They have been called out by several japan bank insiders that this is way too high. Keep in mind that the aging individuals are taking money out of bank to live on. This capital drain will get worse and force banks to start selling JGB’s to maintain some level of capital reserves. Additionally the author does not even talk about demographics. The pension funds will be net sellers of JGBs to meet obligations. Also, he talks about what the BOJ will allow. They do not buy 30 year bonds and they have already started to go up versus the rest of the curve. People are unwilling to lend to the government without getting a higher rate and this will only get worse. More to come later.

With regards to the first point that “Since net stock of private savings is larger than the net stock of public sector liabilities, Koll reckons that the overall effect on the economy would be positive.” Koll seems to ignore the fact that as the population is ageing and eating into their savings, there will not be these savings to put into government bonds. See for example todays article in Bloomberg.com with the headline “Silver Shoplifters Steal Rice as Abe Cuts Welfare to Trim Debt”

Last comment was seven months ago. Seems Mr Bass still loves giving others money? He is so kind to donate his vast wealth to all the other hedge funds, super funds and managed investment funds. Hey Kyle can you spare a fellow a 1/4? perhaps a dime. No just give me a million. Kyle is all whats good about wealth distribution. People give Kyle money, he then gives their money to everyone else. So Mr Bass how is that Japanese short going? I think the answer can be summed up by the lack of comments 7 months later. Crazy Austrians and Crazy Monetarists. perhaps Mr Bass is buying gold before it reachers 10K LOL?